To The Moon

Investors appear ready to starting buying energy stocks again as earnings start rolling in. They are looking to boost their weightings in the sector given healthy free-cash flows (FCF), said analyst Neal Dingmann at Truist.

Dingmann said he had previously believed that many investors would wait another quarter or two to start buying again after companies reported “solid” FCF and after shareholder returns, such as share repurchases and dividends, were announced.

But following talks with a number of exploration and production (E&P) companies and numerous meetings with investors, Dingmann said he believes “demand for energy stocks is about to dramatically increase” as the earnings reports start rolling in.

“While energy investors are not yet stepping into many new positions, our conversations and other dealings suggest that is about to change,” Dingmann wrote in a note to clients.

Dingmann said his note comes after being “on the road extensively” with six E&P companies: APA Corp. APA, +0.43%, Callon Petroleum Co. CPE, Earthstone Energy Inc. ESTE, Matador Resources Co. MTDR, +3.21%, Murphy Oil Corp. MUR, and Northern Oil and Gas Inc. NOG, +4.49%. He has a “buy” rating on all six of those companies.

The SPDR Energy Select Sector exchange-traded fund XLE, which rallied 1.9% in midday trading Monday, has gained 19.2% over the past three months and 47.3% year to date. It is the only SPDR ETF tracking the S&P 500 index’s 11 key sectors that is showing a gain for those time periods.

In comparison, the S&P 500 SPX, which powered up 2.6% on Monday, has lost 4.9% the past three months and tumbled 22.9% in 2022.

About one-third of the companies Dingmann covers are expected to report third-quarter FCF below that seen in the previous quarter, but FCF yields will still be among the highest of any sector. And with the pace of oilfield services (OFS) inflation having slowed, oil rigs and frac spreads (equipment used in hydraulic fracturing, or “fracking”) are starting to become available.

What will also attract more investor interest, Dingmann said, is that third-quarter reports will show that earnings and cash flow continue to represent a much higher portion of the total than what sector weightings in broad-market indexes account for. As a result, he expects “a steady increase” in energy weightings by investors as earnings results are reported.

The first SPDR Energy ETF components slated to report results are Kinder Morgan Inc. KMI, +1.80% and Baker Hughes Co. BKR, +4.45%, both on Oct. 19, followed by Schlumberger Ltd. SLB, +1.66% on Oct. 21.

The S&P 500’s energy sector, which carries a 4.5% weighting in the S&P 500, is expected to report aggregate third-quarter earnings per share (EPS) that are more than double (up 121.3%) those of a year ago, according to FactSet data.

Meanwhile, aggregate EPS for the entire S&P 500 is expected to rise just 1.3% from a year ago.